Korea Market Strategy
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2 February 2017 Asia Pacific/South Korea Equity Research Korea Market Strategy The Credit Suisse Connections Series leverages our exceptional breadth of macro and micro research to deliver CONNECTIONS SERIES incisive cross-sector and cross-border thematic insights for our clients. Research Analysts Unwinding Korea’s discount Gil Kim 82 2 3707 3763 Figure 1: Summary of proposed bills on corporate governance [email protected] Category Summary of proposed bills Minseok Sinn Cross-ownership 82 2 3707 8898 Unwind all existing cross shareholding. [email protected] Holding company Strengthen holdco classification, limit the leverage (debt-to-equity) of holding company, increase minimum required ownership of subsidiaries, prohibiting Michael Sohn ownership of unrelated grand-subsidiaries. 82 2 3707 3739 [email protected] Treasury shares Restriction on use of treasury shares on spin-off, prohibit resale of treasury shares to select company or person. A-Hyung Cho Intra-group transactions 82 2 3707 3735 Strengthen regulation on intra-group revenue transactions. [email protected] Outside BoD Improve independence of BoD, grant minority shareholders the right to appoint BoD members, require cumulative voting. Jennifer Yu 82 2 3707 3738 Derivative lawsuit Shareholders can file a lawsuit against directors of subsidiaries. [email protected] Electronic voting Require electronic voting for all large-size companies. Hoonsik Min National Pension Reform National Pension for more independence and expertise. 82 2 3707 3761 Source: Maeil Economy, Chosunbiz, Ministry of Government Legislation, Credit Suisse research [email protected] Sohyun Lee ■ Political issues, of late, have heightened, and public sentiment is shifting 822 3707 3737 [email protected] towards “economic democratisation". A slew of bills related to corporate governance have been proposed. We delve into all those pending regulations to analyse the impact on, and establish investment opportunities within, the Samsung, Hyundai Motor and Lotte group companies, in expansion to our previous researches on Samsung Group restructuring. ■ The pending bills, if approved, would complicate the ownership restructuring process of large-sized corporates in Korea, in our view. Our base case investment thesis assumes an expedited reshuffling of ownership structure. Based on scenario analyses conducted by CS's research team, transitioning to a holding company is the most feasible ownership restructuring for all three groups. This, in turn, would unlock value for select counters, in our view. We believe Samsung Electronics and Hyundai Motor are key beneficiaries. We upgrade Lotte Shopping to NEUTRAL from Underperform. ■ Under a scenario where the proposed bills are fully enacted, a meaningful improvement in Korea's corporate governance is anticipated, leading to more efficient capital management. Credit Suisse HOLT sees upside of 30% for KOSPI if excess cash and/or capital is redistributed to shareholders. We also believe that a more efficient capital management will unwind Korea's current valuation discount of ~20% against Asia ex-Japan on 12-month forward P/E. DISCLOSURE APPENDIX AT THE BACK OF THIS REPORT CONTAINS IMPORTANT DISCLOSURES, ANALYST CERTIFICATIONS, LEGAL ENTITY DISCLOSURE AND THE STATUS OF NON-US ANALYSTS. US Disclosure: Credit Suisse does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. 2 February 2017 Focus tables Figure 2: Samsung Electronics—estimation of the upside from holdco transition 92 1) Samsung Opco - Value (2017E, Post 2) Samsung Holdco - Value (2017E, Book Value Marked to Wbn) Current Demerger Wbn) Pre-split Market Value Revenue 235,983 235,983 a) LT Investment to Split-off: 5,837 8,541 Operating Profits 42,776 42,776 b) BV of Treasury Shares 10,955 35,476 Interest Income Adjustment 660 c) Cash 30,000 30,000 Equity-method gain Adjustment 400 Holdco Book Value - Marked to Market 46,792 74,018 Pretax Profits 44,346 43,286 Number of Common Shares (mn) 137 Net Income 31,929 31,166 BV per Share (W) 540,274 Total Equity 210,127 163,336 Holdco Shr Val Discount Rate @ 30% (W) 378,192 ROE 15.2% 19.1% Number of common shares(mn) 137 3) Samsung - Split-up Value (2017E, W) 2,653,077 EPS(W) 227,488 Target Multiple 10x 2017 PER(W) 2,274,885 Source: Company data, WISEfn, Credit Suisse estimates Figure 3: HMG—potential upside after the Figure 4: SoTP assuming Lotte Shopping forms restructuring holdco (W bn, %) HMC Kia Mobis Base case Blue sky Current market cap for HMC/Kia/Mobis 31,389 15,302 25,893 Consolidated affiliates 3,639 3,639 Target market cap for Holdco 24,351 9,290 11,137 Opco NAV 1,427 2,959 Target market cap for Opco 38,080 14,145 25,616 Related affiliates 1,346 1,346 Target market cap for HMC/Kia/Mobis 62,431 23,435 36,752 Inv holdings avail for sale 275 275 Upside (%) 99% 53% 42% Brand Royalty 728 728 Treasury 135 135 Net debt 1,751 1,751 Holdco NAV 5,799 7,331 Holdco NAV at 30% discount 4,059 5,132 Opco 7,175 10,492 Net debt 4,087 4,087 Opco NAV 3,088 6,406 Lotte Shopping Holdco+Opco 7,147 11,537 % from current price -2% 59% Base case Blue Sky Opco NAV 1,427 2,959 Source: Company data, Bloomberg, Credit Suisse estimates Source: Company data, Credit Suisse estimates Figure 5: Past CS Korea Research reports on Samsung Group restructuring Date Company Title Link 6/18/2014 Korea Strategy How to untangle Samsung group's ownership? (link) 11/25/2014 SDS A crucial stepstone (link) (link) 1/8/2015 Cheil Industries Anticipation priced in (link) (link) 1/12/2015 SEC Scenarios for company split-up (link) (link) 11/29/2016 Samsung Life Implications of SEC's potential holdco transition (link) (link) 11/29/2016 SEC Key takeaways from the updated shareholder return announcement (link) (link) 12/6/2016 SDS Valuation back to supportive level eventually. Upgrade to Neutral (link) (link) Source: Credit Suisse research Korea Market Strategy 2 2 February 2017 Unwinding Korea’s discount Potential upgrade of Korea's corporate governance could lead to a rerating Political issues, of late, have heightened, and public sentiment is shifting towards “economic democratisation”. A slew of bills related to corporate governance has been proposed. These pending regulations would, in our view, (1) limit controlling shareholders' access to corporate capital at the expense of minority shareholders, (2) reinforce the fiduciary duty and the expertise of National Pension Service Investment Management, and (3) reform the Board of Directors (BoDs) to enhance independence. The fact that more tightened regulations are pending will likely expedite the large conglomerate ownership restructuring process, in our view. In case the proposed bills are approved, it would improve corporate governance reform and capital management, leading to rerating opportunities, in our view. According to HOLT, KOSPI (ex-Financial) offers 30% upside if excess cash is redistributed to the shareholders. Samsung: Reshuffle already irreversible Regardless of the final outcome of the ongoing political churn in Korea, we expect Samsung Group to continue its reshuffling work as it tries to cut flab—this would not only help enhance the controlling family’s governance power in the group but also significantly reduce the gap between the interest of the controlling family and that of the minorities. Indeed, we think Samsung Group may accelerate the pace of the remaining reshuffle. After all, we believe the group will eventually evolve into a dual-layer holding company structure after the split-up of Samsung Electronics (SEC) into a holding company and an operating company, which appears the optimal way to meet the key requirements for the reshuffling work with minimised reputational risk. While the split-up plan requires approval from SEC’s shareholders, we see no major barriers to the approval given the split-up implies an unlocking of underappreciated value in SEC’s investment asset and helps increase the value of the minorities. (Samsung C&T report) Hyundai Motor: Regulations and peer pressure to lead restructuring. We provide three different scenario analyses for Hyundai Motor Group (HMG) and believe splitting three companies (HMC, Kia, and Mobis) into holdco and opco followed by the three holdcos' merger (scenario 1) would be the most suitable scenario for the group. As the group restructuring requires the Chung family's Glovis share swap to get the new holdco shares, Glovis will eventually lose the owner's (Chung family) premium which is a negative for the stock. (Hyundai Glovis report) Lotte: Value accretion from Holdco formation already in the price Lotte Group Chairman's announcement to improve group transparency, and the potential regulation change on holdcos could be strong incentives for Lotte Group to accelerate the procedure to form a holdco. Lotte Group is different from other major Korean conglomerates in that the key affiliate companies are heavily owned by the owner family/ affiliates but complicatedly cross-held. This implies the group will have multiple options to maximise the major shareholders' ownership without much affecting minority shareholders' interests. We expect the initial step would be to merge Lotte Shopping and Lotte Confectionery, and the combined entity to form a holdco. This